Global financial crisis and Sri Lanka
Since early 2007, there had been speculation of a possible recession
starting in early or late 2008 in some countries.
US and UK are clearly in trouble. This could be the worst since World
War II. In August, Germany and France signalled possible recession which
seems a reality now.
Other countries have seen the rate of growth of GDP decrease,
generally attributed to reduced liquidity, sector price inflation in
food and energy, and the US slowdown. These include eurozone
(15-nations), Japan, Australia, China, India and New Zealand.
US will bear the brunt of the economic consequences of the crisis,
with the bulk of the impact not being felt until later in the year if
immediate measures are not taken when the ripple effect will be felt by
UK prime minister, last Tuesday ordered taxpayer-backed cash
injection to rebuild the balance sheets of Britain’s high street banks,
in effect part-nationalising the sector at an estimated cost of between
German output, which accounts for 30 per cent of the 15-nation
eurozone economy, fell by 0.5 per cent in the second quarter, the
weakest performance in more than five years. However, the economy is
still growing at an annual rate of 3.1 per cent. France also posted a
shock fall, shrinking by 0.3 per cent, down from a 0.5 per cent rise in
the first quarter. This was below analysts’ forecasts for a rise of 0.2
per cent. France is the second biggest economy in the eurozone,
accounting for about 16 per cent of output. However, French Economy
Minister, rejected talk of recession in August.
Europe’s manufacturing and service industries recorded slow growth.
The Swiss government reduced its economic growth forecast for next year.
The $700 billion bailout plan
US Congress has signed into law a $700 billion bailout plan, every
one is waiting to see its impact. Up to date over a trillion dollars may
have been pumped to revive the financial system with no light at the end
of the tunnel.
The bailout package will be financed by the US Treasury through
printing money garbed as bonds and bills sold to investors. Another
provision approved by Congress will give further tax cuts to businesses.
It means that some social programmes for poor Americans will be
eliminated because the tax rebates will reduce Government revenues.
The bailout package dollars are being dolled out to Wall Street
players who were responsible for the financial mess. Once again, the
business lobbies, with deep pockets, have prevailed over the common US
Some suggest that the huge bailout package can lead to stagflation
(rising inflation and unemployment) or a depression. It may be perceived
as a disastrous step taken in the direction of same old perilous path
that has sucked in the US and the international financial system.
The lower dollar dragged the last hope of world economies into its
knees. It has an effect on the real economy which will be felt more in
late 2008, with greater intensity in the US, less in other areas. A lot
will have to do with the length of the crisis, the longer it lasts, the
bigger impact it will have.
The most important financial institutions have enough capital to
withstand the shock, and global growth has been solid in 2006 and 2007,
though some slowdown could be expected. But this depends on how these
economies tackle the issue.
The deceleration in the euro-area economy will continue to be felt,
and that leaves the ECB (European Central Bank) with a big problem. The
slowdown in economy and increasing inflation is the last thing ECB wants
The United States housing market correction (a consequence of United
States housing bubble) and subprime mortgage crisis coupled with high
oil prices had significantly contributed to the current recession.
U.S. employers shed 63,000 jobs in February 2008, the most in five
years. Former Federal Reserve chairman said in April 6, 2008 that “There
is more than a 50 percent chance the United States could go into
On October 1st, the Bureau of Economic Analysis reported that an
additional 156,000 jobs had been lost in September. In April 2008, nine
US states were declared to be in a recession.
Although the US Economy grew in the first quarter by 1%, by June 2008
some analysts stated that due to a protracted credit crisis and “rampant
inflation in commodities such as oil, food and steel”, the country was
nonetheless in a recession.
The evidence has built to the point that it is now beyond a
reasonable doubt that the U.S. economy has entered recession.
What is recession?
Recession is a contraction phase of the business cycle. Broadly it is
a significant decline in economic activity spread across the economy,
lasting more than a few months, normally visible in real GDP, real
income, employment, industrial production, and wholesale-retail sales. A
sustained recession may become a depression.
Causes of recessions
Currency crises, inflation, national debt, speculation, war can all
lead to a recessions.
Effects of recessions
Bankruptcies, banks lend less money, deflation, foreclosures, reduced
sales, stock market crash, unemployment are the effects of a recessions.
Predictors of a recession
There are no completely reliable predictors. These are regarded to be
possible predictors. It is the opinion of the writer that unlike in the
past predicting the present day economic activities of the nations are
far more difficult. This is due to the web like tangles, complex
connections and links of the economies of world.
Responding to a recession
Strategies for moving an economy out of a recession vary depending on
which economic school the policymakers follow. While Keynesian
economists may advocate deficit spending by the Government to spark
economic growth, supply-side economists may suggest tax cuts to promote
business capital investment.
Laissez-faire economists may simply recommend the Government remain
“hands off” and not interfere with natural market forces. Populist
economists may suggest that benefits for consumers, in the form of
subsidies or lower-bracket tax reductions are more effective, and serve
a double purpose including relieving the suffering caused by a
Both Government and business have responses to recessions.
Precautions businesses can take
First business owners can gauge customers’ ability to resist
recession and redesign customer offerings accordingly. Lean principles
can be used, replace unhappy workers with those more motivated, eager
and highly competitive. After all on the bright side companies, get
better at what they do during bad times.
Central Bank response
Usually, Central Bank’s respond to recessions by easing monetary
conditions, e.g. lowering interest rates. In the US, the Federal Reserve
has responded to potential slow downs by lowering the target Federal
funds rate during recessions and other periods of lower growth.
Cuts in the interest rates are now widely anticipated; thus, cuts are
no longer followed by a longer-term rise in stock market indexes.
Due to the global nature of the current crisis Sri Lanka will no
longer be able to escape unharmed this time around. The impact will
depend on the sectors in varying levels. For example, there will be less
tourist arrivals from European countries and that will affect the all
ready troubled sector.
Rising interest rates and inflationary pressure, US dollar
appreciating at the expense of the rupee coupled with a war budget and
high public sector expenditure will make things difficult for Sri Lanka.
Few weeks back, Central Bank (CBSL) released more than US$ 22 million
into the market in order to defend the rupee. Less and less dollars
coming into the markets causes pressure on the rupee thus making it
difficult for the (CBSL) to defend the rupee. It is expected the dollar
to end at the Rs. 109 levels soon.
As a result the economy may be go into a recession, with cascading
effects on the US, EU economy and on the rest of the world as well,
because of their dependency on the US economy. The worse is to follow,
when foreign funds try to withdraw their funds from Asian markets.
However inward remittances sent in by Sri Lanka’s housemaids in the
Middle East and expats may result the country achieving a reasonable
outcome in relation to the trade deficit.
Above factors combined will have a detrimental impact on the economic
growth if steps are not taken to mitigate the impact.
The way out for Sri Lanka
If the global crisis continues although Sri Lanka will not be able to
totally avoid its consequences if certain steps are taken we can avoid a
great impact and also will be able to develop the economy.
The continuation US and the Eurozone economic down turn will have a
negative impact on the Lanka’s textile and garments exports. Nearly 50
per cent of Sri Lanka’s textile and garments exports went to the US in
2007 while another 45 per cent went to the EU.
The sector is the largest source of foreign exchange earnings,
accounting for some 43 percent of the total.
Elimination of terrorism
The 2009 defence budget is estimated at 177.06 billion rupees, 6.4
per cent higher than the estimated 166.45 billion rupees to be spent in
2008. This can be considered as an essential expenditure for future
stability of the country.
But this expenditure should not continue beyond 2009. Expected
possible gains will not only be lost if the war is prolonged but will
have a devastating affect on the economy.
If terrorism is eliminated or controlled at least by the mid to end
of 2009 the positive ripple effect will see Sri Lanka to an economic
In fact 177.06 billion rupees hopefully will be available for
development and capital expenditure.
Development of rural industries
The industrial sector has been a significant contributor to the Gross
Domestic Product (GDP) of the country (27%). But this sector is
predominantly confined to the cities of Gampaha and Colombo.
Development of rural industries will see the uplift of that sector
and more economic stability in the country despite the global crisis.
If the Government plans to introduce 300 industries under the Gamata
Karmantha project goes well, it will cater the growing demand for
employment in rural areas.
This project includes 123 programmes with a total investment of
Rs.18, 217 million and is expected to generate 26,212 jobs. Of these
projects, 27 are in commercial enterprises, 26 pertaining to
construction and 23 engaged in preliminary work.
The electrical and electronic sector is another key area that should
be earmarked for development.
Developing small and medium business enterprises
Small businesses account for the bulk of businesses in Sri Lanka.
Assistance for the development in this sector will create immense
benefits to the economy.
This can be achieved by providing equity capital, expertise and
technical assistance, corporate governance advice and management of
environmental and social risks.
The development and regulating the local financial market and the
(high-speed) internet are other key development areas. But what should
be at the core of the development strategy is the curbing of corruption
and public expenditure.
(The writer is a resident of Australia and is practising as an
Australian Solicitor and Barrister. He can be contacted on [email protected])